Venture Capital Funds and Private Equity Funds

How a Private Equity Fund is formed and run

A private equity fund is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity. Private equity funds are typically limited partnerships with a fixed term of 10 years (often with annual extensions). At inception, institutional investors make an unfunded commitment to the limited partnership, which is then drawn over the term of the fund. From investors point of view funds can be traditional where all the investors invest with equal terms or asymmetric where different investors have different terms.
A private equity fund is raised and managed by investment professionals of a specific private equity firm (the general partner and investment advisor). Typically, a single private equity firm will manage a series of distinct private equity funds and will attempt to raise a new fund every 3 to 5 years as the previous fund is fully invested.
Most private equity funds are structured as limited partnerships and are governed by the terms set forth in the limited partnership agreement or LPA. Such funds have a general partner (GP), which raises capital from cash-rich institutional investors, such as pension plans, universities, insurance companies, foundations, endowments, and high net worth individuals, which invest as limited partners (LPs) in the fund. Among the terms set forth in the limited partnership agreement are the following:

Term of the partnership
The partnership is usually a fixed-life investment vehicle that is typically 10 years plus some number of extensions.
Management fees
An annual payment made by the investors in the fund to the fund's manager to pay for the private equity firm's investment operations (typically 1 to 2% of the committed capital of the fund.

Hurdle rate or preferred return
A minimum rate of return (e.g., 8–12%), which must be achieved before the fund manager can receive any carried interest payments.

Carried interest
A share of the profits of the fund's investments (typically up to 20%), paid to the private equity fund's management company as a performance incentive. The remaining 80% of the profits are paid to the fund's investors.

Transfer of an interest in the fund
Private equity funds are not intended to be transferred or traded; however, they can be transferred to another investor. Typically, such a transfer must receive the consent of and is at the discretion of the fund's manager.

Restrictions on the General Partner
The fund's manager has significant discretion to make investments and control the affairs of the fund. However, the LPA does have certain restrictions and controls and is often limited in the type, size, or geographic focus of investments permitted, and how long the manager is permitted to make new investments.
Private Equity Investments and Financing
A private equity fund typically makes investments in companies (known as portfolio companies). These portfolio company investments are funded with the capital raised from LPs, and may be partially or substantially financed by debt. Some private equity investment transactions can be highly leveraged with debt financing—hence the acronym LBO for "leveraged buy-out". The cash flow from the portfolio company usually provides the source for the repayment of such debt.
Such LBO financing most often comes from commercial banks, although other financial institutions, such as hedge funds and mezzanine funds, may also provide financing. Since mid-2007, debt financing has become much more difficult to obtain for private equity funds than in previous years.
LBO funds commonly acquire most of the equity interests or assets of the portfolio company through a newly created special purpose acquisition subsidiary controlled by the fund, and sometimes as a consortium of several like-minded funds.

Capital Gain or Income : Trump could target 'carried interest' tax loophole.

The Trump administration's push to overhaul tax laws might soon target a loophole used by some financial managers to lower their tax rates, White House Chief of Staff Reince Priebus said on Sunday.
President Donald Trump campaigned before the Nov. 8 election to eliminate the so-called "carried interest" loophole, which is used by many financial managers to lower tax obligations. But a rough outline for a major tax overhaul released last week failed to mention the loophole.
Priebus, however, hinted that carried-interest could be on the chopping block and warned against analysts taking the view that financial managers would keep on benefiting from it.
"Carried interest is on the table," he said. "The president wants to get rid of carried interest so that balloon is not going to stay inflated very long, I assure you of that."

The carried interest rule allows financial managers at private equity, hedge fund and other firms to pay a capital gains tax rate on their income instead of the higher income tax rate.

Alternative investment funds -From Regulatory perspective, investor protection is not the objective as it relates to informed invetors. SEBI is out to do more than just investor protection. It needs to contain systemic risk.Hence this.

Question to SEBI : Your recent regulation was on alternative investment funds such as private equity, venture capital funds and so on. These are vehicles for informed investors. Why the regulation?

Answer: SEBI has two guiding principles. One is investor protection and the other is containing systemic risk. In 2008, large pools of money were used to play the stock market, without anybody even having an idea of the dimension of the problem. If we had the data on these funds, we may have been alerted to the crash. That is why we would like to regulate alternative investment funds. If you are setting up a PE, VC or hedge fund, you cannot collect less than Rs 1 crore. And anyone collecting above Rs 1 crore per investor has to register with us and be regulated.

On investor protection, we are looking at a hierarchy of regulations. For mutual funds, where one can invest Rs 500-1,000, regulations will be tight, as these are uninformed investors. Alternative investments will have light-touch regulations. We have set the threshold at Rs 1 crore. The idea is that the uninformed retail investor will be permitted to invest only in areas where regulation is tight.
So was there a regulatory vacuum in terms of large entities raising money and not being regulated?

Yes. Previously there was no requirement that all venture funds must register with SEBI. Now that has been changed. All venture capital funds which raise domestic money need to be registered with us. The concept is that if anyone is raising money in India they need to be registered with us. If they don't register, they are violating rules.
To give an example, in 2005, 2006 and 2007, many firms raised money for real-estate. They pooled small sums of money such as Rs 5 lakh and that went into real-estate funds. Now, even for activities like that, the minimum investment is Rs 1 crore. Now, some people may not be happy with that. But we feel that these vehicles are not suitable for small investors.
The original concept paper asked alternative funds to register under seven categories. You have now reduced that to three broader categories. Why?
We felt that administrating the seven categories will pose a problem. Besides, the firms felt that water-tight compartments will restrict their mandate.
Therefore, we tweaked this based on whether alternate funds get some concessions from the government. Venture funds invest mainly in unlisted securities. They get regulatory forbearance, for instance, a pass-through status on taxes because we feel they are a good means to promote entrepreneurship. The second category is private equity, which can invest in public securities. They too get certain facilities from the government. These two categories need to accept restrictions, they can't use leverage.

The third category is hedge funds, which don't get any facilities from the government and are allowed to leverage. Hedge funds globally do rely on leverage and to restrict this would be not be in keeping with trends across the world.
However having said this, we have to watch the extent to which they are allowed to borrow and the size of such funds in the Indian market. For this they need to be registered. For instance in 2006, 2007, many such firms raised $ 1-2 billion funds and nobody did much about them. But this applies only to funds raising money from Indian investors. Hedge funds and others who raise money from abroad will come under the FII regulations.

You spoke of filling the regulatory vacuum. What about collective investment schemes such as teak schemes, gold bonds and so on?
Yes I agree there are grey areas there. Now, collective investment schemes are to be regulated by SEBI. But we find that very few schemes are willing to submit themselves; they usually claim that they are not collective investment schemes. They are generally taking advantage of the Chit Fund Act or are NBFCs.
In one or two States, this activity has been going on in a big way. The money is often collected from remote areas. We have issued orders in some cases against such firms, but they have gone to Court over this. In the case of collective investment schemes, we need clarity on who the enforcement agency is.
 SEBI Chairman, Mr U.K. Sinha. Excerpts from an interview.(This article was published on May 12, 2012 in Business Line)

SEBI registered private Equity Realty Funds in India. 
July 16, 2013:  
About fifteen new real estate funds have registered with market regulator SEBI after the new Alternative Investment Fund (AIF) regulations took effect in May 2012. New funds had applied for registration last year and SEBI had been granting approvals since October 2012. Early funds started raising funds in the recent quarter and around ten funds are in various stages of raising capital.
All private equity funds were asked to raise their investment limits in May 2012 by SEBI in order to better regulate the industry. The new rules have increased the minimum investment size for investors to Rs 1 crore.
Real estate-focused private equity funds are struggling for a come-back this year, after difficult fund-raising atmosphere in the last two years. Data from Venture Intelligence, a research service focused on private equity, shows that three real estate funds raised $120 million in the recent April-June quarter, much lower than the $295 million raised during the same period last year.
There are lingering concerns that the higher limit can throw up challenges in raising capital. “Setting the minimum limit at Rs 25 lakh would have opened up the funds to more investors” opined Chinnu Senthilkumar, co-founder and a shareholder at private-equity firm Azure Capital Advisors.
However, Nitin Goel, Partner, Real Estate Investments at Milestone Capital, believes that funds with a good track record of providing exits and returning money back to the investors should not be adversely impacted.
Also, domestic funds have been able to demonstrate good performance in the last few years, even while foreign funds have lagged. This will also be favourable for these funds to help attract capital.
The higher investment limit, also accentuates the role of overseas investors. Anuj Puri, Chairman and Country Head, Jones Lang LaSalle India, expressed optimism on investments from overseas investors in the next couple of years and estimated that there could be robust inflows of $4-5 billion.
So where are these funds expecting to invest the capital for generating returns? Funds see the residential segment as promising, as there is ‘strong demand’ at reasonable pricing and a large estimated supply shortfall. While the retail and commercial segments are deeply linked to the general economic conditions, the residential market is perceived to be more resilient.
“The residential landscape looks very promising, and is set to witness many large deals in the near future” says Shrinivas Rao, CEO — Asia Pacific, Vestian Global.
There is also a trend towards city-centric properties compared to tier-2 and tier-3 cities. For instance, Jones Lang LaSalle’s Segregated Funds Group raised Rs 101 crore in the last quarter for its fund focussed on residential developments in seven cities. Funds are also showing a preference for debt or debt-like exposures. According to Sanjay Dutt, Executive Managing Director — South Asia, Cushman and Wakefield India, PE firms are opting for preferred deals with builders. The typical expectation is a 25 per cent return with an 18 per cent guarantee. This offers return protection and the funds work towards gaining the extra 7 per cent which is based on the builder’s profits.
Return guarantees are preferred by investors too, according to Saurabh Gupta of IIFL Real Estate Fund, as periodic income distributed helps the investor’s cash flows.
Among the various markets, Bangalore witnessed the highest number and value of private equity investments at Rs 3,250 crore in 2012, double that of 2011. (This article was published on July 16, 2013 in Business Line)

Venture Capital Success Stories

Benchmark venture capital fund
PALO ALTO: These are fabulous times in Silicon Valley.Mere youths, who in another era would just be graduating from college or perhaps wondering what to make of their lives, are turning down deals that would make them and their great-grandchildren wealthy beyond imagining. They are confident that even better deals await.

"Man, it feels more and more like 1999 every day," tweeted Bill Gurley, one of the valley's leading venture capitalists. "Risk is being discounted tremendously."

That was in May, shortly after his firm, Benchmark, led a $13.5 million investment in Snapchat, the disappearing-photo site that has millions of adolescent users but no revenue. Snapchat, all of two years old, just turned down a multibillion-dollar deal from Facebook and, perhaps, an even bigger deal from Google. On paper, that would mean a fortyfold return on Benchmark's investment in less than a year.

Benchmark is the 
venture capital darling of the moment, a backer not only of Snapchat but the photo-sharing app Instagram (sold for $1 billion to Facebook), the ride-sharing service Uber (valued at $3.5 billion) and Twitter ($22 billion), among many others. Ten of its companies have gone public in the past two years, with another half-dozen on the way. Benchmark seems to have a golden touch.

That is generating a huge amount of attention and an undercurrent of concern. In Silicon Valley, it may not be 1999 yet, but that fateful year - a moment when no one thought there was any risk to the wildest idea - can be seen on the horizon, drifting closer.

No one here would really mind another 1999, of course. As a legendary 
Silicon Valleybumper sticker has it, "Please God, just one more bubble." But booms are inevitably followed by busts.

"All business activity is driven by either fear or greed, and in Silicon Valley we're in a cycle where greed may be on the rise," said Josh Green, a venture capitalist who is chairman of the National Venture Capital Association.

For Benchmark, that means walking a narrow line between hyping the future - second nature to everyone in Silicon Valley - and overhyping it.

Opinions differ here about exactly what stage of exuberance the valley is in.

 Jeremy Stoppelman, the chief executive of Yelp. "That makes people nervous."

John Backus, a founding partner with New Atlantic Ventures, says he believes it's more like 1996: Things are just ramping up.

The numbers back him up. In 2000, just as the dot-com party was ending, a record number of venture capitalists invested a record amount of money in a record number of deals. Entrepreneurs received more than $100 billion, a tenfold rise in dollars deployed in just four years.

Much the money disappeared. So, eventually, did many of the entrepreneurs and most of the venture capitalists.

Recovery was fitful. Even with the stock market soaring since the recession, venture money invested fell in 2012 from 2011, and then fell again in the first half of this year. Predictions of the death of venture capital have been plentiful.

For one thing, it takes a lot less money to start a company now than it did in 1999. When apps like Instagram and Snapchat catch on, they do so in a matter of months. Venture capitalists are no longer quite as essential, and they know it. Just last week, 
Tim Draper, a third-generation venture capitalist with Draper Fisher Jurvetson, said he was skipping the next fund to devote his time to his academy for young entrepreneurs.

But there are signs of life. Funding in the third quarter suddenly popped, up 17 per cent from 2012.
"I think this is the best time we've seen since 1999 to be a venture capitalist," Backus said.

He expects the returns on venture capital, which have been miserable since the bust, to greatly improve this year.

"Everyone talks about the mega-win - who was in Facebook, Twitter, 
Pinterest," he said. "But the bread and butter of venture firms is not those multibillion exits but the $200 million deals, and there are a lot of those."

As an example he pointed to 
GlobalLogic, which operates design and engineering centers. It was acquired in October in a deal that returned $75 million on New Atlantic's $5 million investment.

Better returns would influence 
pension firms and other big investors to give more money to the venture capitalists, which would in term ramp up the number of deals.

"I would be really scared if all of sudden the industry raised $100 billion," Backus said. "But I don't know how you can stop that. The greed factor kicks in. Everyone wants a piece of action."

Benchmark is putting together a new investment fund. Given its recent track record, it could easily raise $1 billion from its limited partners. Instead, it will keep the fund to its usual size, $425 million. That is a hallmark of the discipline that has attended Benchmark since its founding in 1995. While other 
venture capital firms have bulked up, offering more services to entrepreneurs, Benchmark has stayed lean.

Its founding partners did not put their name on the door, a way of stressing that all were equal and would share in the profits equally. For 
Silicon Valley venture capitalists, this was a radical move. A rival venture capitalist told an industry publication that this was "communism."

Benchmark's first fund quoted Voltaire: "God is not on the side of the big arsenals, but on the side of those who shoot best." Its great dot-com hit was eBay, which was considered at the time the greatest venture capital success ever. In Randall Stross' fly-on-the-wall 2000 book, "eBoys," the partners are depicted as hardworking, smart and making it up as they go along, in the best venture capital tradition.

Now the partners are mostly different, but the one-for-all and all-for-one philosophy is the same, and the hits have kept coming.

Gurley, perhaps the best known of the partners at Benchmark, declined to be interviewed, as did the other partners, a spokeswoman said. But the executives of their portfolio companies were eager to discuss their skills.

Jess Lee, the chief executive of the shopping site Polyvore, said that Peter Fenton, the Benchmark partner on her board, was always encouraging long-term thinking.

"He wants us to focus on building the most impactful, sustainable business - an organization that lasts, versus take the best offer you can now," said Lee in a phone interview from a
Goldman Sachs conference in Las Vegas.

When the Snapchat news was breaking, Gurley did not post another reference to 1999, the year the venture capital industry went crazy and valuations of revenue-less companies like Snapchat rose to incredible levels. Instead, he promoted the service, noting that "many adults still don't understand the draw of Snapchat." He has also pointed out that many enduring companies had no revenue in the beginning.

Half of Silicon Valley argues that Snapchat is a flash in the pan, which means its fate will be revelatory as well as entertaining to watch. Perhaps it will indeed rank with the likes of Google or Yahoo. Or perhaps it is

"I don't think we'll ever get back -and should never get back - to the days of the late 1990s," said Green, the venture capital association chairman. "But in venture capital we live in 
alphaworld. It's all about taking risks. This will not be orderly." 27Nov 2013: David Streitfeld

Sequoia Capital - India 

Sequoia Capital has been an early investor in companies such as Google, Cisco, Yahoo, YouTube, Oracle and Apple Computers.  Sequoia Capital maintains dedicated teams in the US, China, India and Israel. 
Sequoia Capital India currently manages funds capitalized at close to US $1.8 billion and invests across venture, growth and late stage opportunities. It takes a long term view on investments and plays the role of an active, value added partner to entrepreneurs, business families and management teams. Over the last 8 years, Sequoia Capital India has invested in more than 50 Indian companies including Applabs, Café Coffee Day, Comviva (Bharti Telesoft), , Dr Lal Pathlabs, Edelweiss, Firstsource, GVK Biosciences, Idea Cellular, Just Dial and SKS Microfinance.  Sequoia Capital India operates out of offices in Bangalore, Mumbai and Silicon Valley. Globally, Sequoia Capital has an unparalleled track record of partnering with entrepreneurs to create global market leaders.

The company is looking to invest $500-600 million over the next three to four years in its traditional focus sectors of healthcare, infrastructure, agri-business and education, among others.

Managing director GV Ravishankar  said the outlook for early-stage venture financing in the country was bright with significant growth was expected over the next few years and entrepreneurs coming up with low-cost models for education and healthcare.

“Our model is to find a good company in a good market, be invested and grow with the company,” he told the media. Sequoia’s India corpus is $1.4-1.5 billion, of which $900 million has been invested in about 50 companies in the last 10 years.

Sequoia’s typical investments were in the range of $5-25 million, and the exit is usually after five years. Its three recent full or partial exits from SKS Microfinance, Paras Pharma and Manappuram Finance had been good, Ravishankar said.

In the next 12-18 months, another 6-8 companies would go public, he said indicating it could consider exiting from these. Lovable Lingerie, from which Sequoia recently exited, has its IPO ongoing, while Micromax is in the pipeline.

March 16, 2011 Business Standard